How to Avoid Taxes on Real Estate Investments: a Case Study

When co-owners of an appreciated property decide to exit, they don't always want the same thing. Questions about how to avoid taxes on real estate investments almost always surface in the conversation, but tax deferral is often just one of several competing priorities. One owner may need cash for the next project. Another may want to stay invested on a tax-deferred basis. A conventional cash sale can deliver liquidity, but it cannot serve both goals at once.

That was the issue facing the owners of a 260-unit multifamily community in the Tampa area. The property had appreciated substantially, a rapid rise in interest rates had closed the door on refinancing, and the existing loan carried a prepayment penalty that further narrowed the path forward. Together, those constraints left the ownership group with limited room to maneuver.

What they needed was a structure capable of producing two distinct outcomes through a single coordinated transition. This analysis examines their objectives and constraints, how a partial UPREIT addressed them, and what the transaction reveals about planning an exit when co-owners are pulling in different directions.

The Ownership-Transition Challenge

The developer and sponsor had partnered to build the 260-unit community in 2019. As the property appreciated, the ownership group accumulated $48.5 million in equity. That growth created an opportunity to exit, but it also increased the potential tax consequences of an outright sale.

The owners initially faced two familiar paths: sell the property or refinance it. Neither was clean. By early 2023, the Federal Reserve had raised the federal funds rate from near 0% to 4.25%-4.50% across seven consecutive hikes: a swing of more than four percentage points in under a year, making new debt expensive enough to take refinancing off the table. The existing loan also carried a prepayment penalty that complicated any conventional sale, and its low loan-to-value ratio made the debt less attractive for an incoming buyer, who would need to contribute substantially more equity to close.

The harder problem was what would happen to the equity after the transaction. The developer wanted liquid capital to fund the next development and had no interest in tying up proceeds in replacement property. The sponsor wanted to step away from active management while staying invested in multifamily real estate, thus preserving income, deferring taxes where possible, and maintaining exposure to the asset class.

No single outcome could satisfy both. An all-cash sale would provide the developer with the liquidity it needs, but it would end the sponsor's real estate position and trigger full gain recognition. Rolling all proceeds into replacement property could serve the sponsor's goals, but it would lock out the developer from accessing capital for the next project.

The ownership group needed a transition path that could accomplish all five things simultaneously:

Those five requirements set the terms for evaluating every available ownership-transition option.

Evaluating Four Ownership-Transition Paths

With the owners' objectives defined, the next step was to determine which transition path could accommodate them. The right structure needed to provide liquidity to the developer, preserve the sponsor's continued multifamily exposure, and account for the property's existing obligations.

How Each Path Fits the Owners' Goals

Cash sale. This would have provided the developer with liquidity and ended both owners' responsibilities for the property. However, it would also have ended the sponsor's real estate exposure and triggered recognition of the gain.

Refinance. New financing could have unlocked some equity without a taxable sale, but both owners would have remained tied to the property. Higher interest rates and the existing loan terms also made this path less attractive.

Direct 1031 exchange. A qualifying exchange could have preserved tax deferral for the sponsor, but it would have required the owners to identify and acquire replacement property within IRS deadlines. Full reinvestment also conflicted with the developer's need for cash.

Partial UPREIT. This structure could divide the consideration between cash and operating partnership, or OP, units. The developer could pursue liquidity, while the sponsor could remain invested in multifamily real estate through passive ownership without searching for replacement property.

Viewed against the owners' requirements, the partial UPREIT addressed more of the transition goals within a single transaction. Bonaventure could then structure the property acquisition, equity allocation, and preferred equity payoff around that path.

How Bonaventure Structured the Transition

Bonaventure acquired the property in January 2023 through a partial UPREIT transaction. Instead of directing all $48.5 million in equity toward cash or continued ownership, the structure divided it according to the owners' objectives.

What the Allocation Accomplished

• The sponsor remained invested. The sponsor exchanged $27.6 million in equity for OP units in BMIT**.
• Both owners received liquidity. The sponsor received $7.6 million in cash, while the developer received $8.3 million for another development opportunity.
• The preferred equity was retired. The transaction directed $5 million toward paying off the preferred equity tied to the property.
• Management transferred to Bonaventure. The sponsor exchanged direct ownership and management responsibilities for an interest in the operating partnership.
• The sponsor's $7.6 million cash allocation was not subject to Section 721 treatment. Gain attributable to that portion was recognized in the year of the transaction.

The result was a coordinated closing in which 57% of the property's equity remained invested, and 43% went toward owner liquidity and the preferred equity payoff. Further, the distributions through the new structure replaced the sponsor's previous property-level distributions.

This allocation is important when evaluating the transaction's tax implications. Only the $27.6 million OP-unit portion remained invested through the UPREIT. Not all of the $48.5 million received the same treatment.

How to Avoid Taxes on Real Estate Investments Through Deferral

Property owners researching how to avoid taxes on real estate investments should distinguish tax deferral from permanent tax elimination. In this transaction, tax deferral supported the sponsor's goal of remaining invested, but it was only one part of the broader ownership-transition strategy.

Section 721 generally allows an owner to contribute qualifying property to a partnership in exchange for a partnership interest without immediately recognizing the associated gain. Here, that treatment applied to the sponsor's qualifying OP-unit contribution, not to every dollar of the property's equity.

What the Transaction Demonstrates About Ownership-Transition Planning

The transaction offers several lessons for owners preparing to exit an appreciated multifamily property.

A Coordinated Approach to Ownership Transition

Ownership-transition strategies can have a significant impact on how much capital investors preserve and how they remain invested after a sale, including how to avoid taxes on real estate investments that would otherwise erode the equity they've spent years building. This transaction shows how custom structuring can accommodate liquidity, continued investment, and passive ownership in a single closing.

Bonaventure combines multifamily acquisition and operating experience with partial UPREIT, Section 721, custom 1031 exchange, and DST capabilities. That range allows the firm to structure around the property's capital stack and each owner's plans rather than applying the same solution to every stakeholder.

Owners considering a transition should begin evaluating their options before committing to a sale structure. Early coordination among the owners, Bonaventure, and their legal and tax advisors creates more room to address debt, equity allocations, tax considerations, and long-term investment goals.

Explore how Bonaventure can structure an ownership transition around your property and the outcomes you want to achieve.

Schedule an Ownership-Transition Consultation

*The article is for informational purposes only and not intended to be all-inclusive and may be changed at any time without notice or obligation to update. This information is for educational purposes only and does not constitute tax, legal, or financial advice. Bonaventure does not provide tax, legal, or accounting services. Tax laws and regulations are subject to change, and individual circumstances vary. Investors should consult their own tax advisor, attorney, or qualified intermediary regarding their specific situation before pursuing any of the strategies discussed.

**This material is not an offer to sell or a solicitation of an offer to buy any interest in the Bonaventure Multifamily Income Trust or any fund sponsored by Bonaventure or its affiliates. Any offering is made only pursuant to a confidential private placement memorandum (PPM) and related offering documents, which should be reviewed in full and which control in the event of any inconsistency with this material. Certain statements are forward-looking and subject to risks and uncertainties. BMIT interests are not registered under the Securities Act of 1933 or any state securities laws, and BMIT is not registered under the Investment Company Act of 1940. Securities offered through Preferred Capital Securities, member FINRA/SIPC.

DISCLOSURES

THE RISKS ASSOCIATED WITH INVESTING IN A REAL ESTATE PRIVATE EQUITY FUND GENERALLY INCLUDE:

Limited Regulatory Oversight - Since private equity funds are typically private investments, they do not face the same oversight and scrutiny from financial regulatory entities such as the Securities and Exchange Commission ("SEC") and are not subject to the same regulatory requirements as regulated investment companies, including requirements for such entities to provide certain periodic pricing and valuation information to investors. Private equity offering documents are not reviewed or approved by the SEC or any US state securities administrator or any other regulatory body. Also, managers may not be required by law or regulation to supply investors with their portfolio holdings, pricing, or valuation information.

Strategy Risk - Many private equity funds employ a single investment strategy. Thus, a private equity fund may be subject to strategy risk, associated with the failure or deterioration of an entire strategy.

Use of Leverage and Other Speculative Investment Practices - Since many private equity fund managers use leverage and speculative investment strategies such as options, investors should be aware of the potential risks. When used prudently and for the purpose of risk reduction, these instruments can add value to a portfolio. However, when leverage is used excessively and the market goes down, a portfolio can suffer tremendously. When options are used to speculate (i.e., buy calls, short puts), a portfolio's returns can suffer and the risk of the portfolio can increase.

Past Performance - Past performance is not necessarily indicative and is not a guarantee of a private equity fund's future results or performance. Some private equity funds may have little or no operating history or performance and may use hypothetical or pro forma performance that may not reflect actual trading done by the manager or advisor and should be reviewed carefully. Investors should not place undue reliance on hypothetical or pro forma performance.

Limited Liquidity - Investors in private equity funds have limited rights to transfer their investments. In addition, since private equity funds are not listed on any exchange, it is not expected that there will be a secondary market for them. A private equity fund's manager may deny a request to transfer if it determines that the transfer may result in adverse legal or tax consequences for the offering.

Tax Risks - Investors in certain jurisdictions and in private equity funds generally may be subject to pass -through tax treatment on their investment. This may result in an investor incurring tax liabilities during a year in which the investor does not receive a distribution of any cash from the Fund. In addition, an investor may not receive any or only limited tax information from private equity funds may not receive tax information from underlying investments in a sufficiently timely manner to enable an investor to file its return without requesting an extension of time to file.

Reliance on Fund Manager; Lack of Transparency - A private equity offering's manager or general partner has total investment authority over the private fund. There is often a lack of transparency as to a private equity offering's underlying investment. Because of this lack of transparency, an investor may be unable to monitor the specific investments made by the offering or to know whether the investments are consistent with the sponsor's historic investment philosophy or risk levels.

Due to the risks mentioned above, it is important to perform proper due diligence in evaluating and choosing private equity managers to place your money with. There have been occasions when private equity fund managers took on too much risk in their portfolio and lost a substantial amount of their investors' money.